Milling under the weight of rising bad loans when public sector banks (PSBs) are slowing down credit flow to productive sectors of the economy, other forms of finance are emerging stronger.

According to the latest annual report of RBI, during Q1 of FY18, as against negative incremental rise in bank credit, the non-bank sources gained space in lending. The total flow of funds to the commercial sector from non-bank sources during the period increased to Rs 1,16,600 crore while the formal banking system trailed behind.

Many corporate houses source funds from non-bank sources. In terms of financial assets, NBFCs recorded a healthy growth — a compound annual growth rate (CAGR) of 19% in the past few years — comprising 13% of the total credit and are expected to reach nearly 18% by 2018-19.

Funds can be accessed by borrowers from traditional sources such as commercial banks, non-banking financial companies (NBFCs) and external commercial borrowings (ECBs). Funds can also be raised by entrepreneurs through public deposits, equity and debt instruments such as bonds, debentures and hybrid products.

The cost of borrowing funds depends on the standing of the borrower, credit rating, net worth and availability of funds at ongoing interest rates. Apart from these age-old modes, an innovative mode of peer to peer (P2P) is fast occupying the funding space as a non-bank entity.

P2P Lending

P2P lending is a form of crowd-funding used to raise loans, which are paid back with interest. It can be defined as the use of an online platform that matches lenders with borrowers in order to provide unsecured loans. The borrower can either be an individual or a legal person and the interest rates are set by the platform or by mutual agreement between the borrower and lender.

Fees are paid to the platform by both the lender and the borrower. The borrower pays an origination fee (either a flat rate fee or as a percentage of the loan amount raised) according to his/her risk category. It is a form of service of loan facilitation, via online medium or otherwise, to the participants who have entered into an arrangement with that platform to lend on it or to avail of loan facilitation services provided by it.

Evolution of P2P

Till end of 2015, the estimated volume of P2P lending operations in global markets stood at 4.4 billion GBP, up from 2.2 million GBP in 2012. It has grown at an exponential rate indicating the expanding scope. While it is a regulated activity in the US, UK, France, Germany, Italy and Australia, it is unregulated in China. It is banned in Israel and Japan.

P2P lending is at a nascent stage in India. It is approached differently by regulators in different jurisdictions, treated as banking in some jurisdictions and as a non-bank intermediary in some others.

In India, there are many online P2P lending platforms. Some of these are involved in the businesses targeted at microfinance activities with the primary goal being social impact and providing easier access of credit to small entrepreneurs. Some 30 online P2P lending institutions were in operation till April 2016, but it is gaining popularity. Looking at its potential, the RBI has proposed to regulate it.

Operating Model

P2P lending promotes alternative forms of finance, where formal finance is unable to reach and also has the potential to soften the lending rates. Lower operational costs and simplified abilities to compete with traditional lending channels make it useful to the informal sector. If properly regulated, the P2P lending platforms can do this more effectively.

P2P lending platforms are generally technology companies registered under the Companies Act 2013. Both prospective lenders and borrowers are to be registered on the platform when due diligence will be carried out. Those found eligible will be allowed to participate as lenders or borrowers.

The companies follow a bid and ask procedure where the borrowers may or may not accept for proposed amount, tenor and interest rate. When the terms are accepted, the deal of lending and borrowing is undertaken. It is the mutual terms on which the borrower and lender accept to complete the transaction at the agreed rate of interest.

Such P2P platforms also extend the services of credit assessment, credit score validation, documentation, entering into loan contracts, stamping, execution and ultimately recovery of loans. Disbursement of loan funds is done through the designated bank account of the borrower from the lenders account. P2P operators are supposed to follow legal protocols in completing the deals.

Regulatory Dispensation

Regulations for smaller NBFCs that are not systemically important have been rationalised while systemically important NBFCs have been continuously regulated to bring them on a par with global standards.

According to the RBI, no NBFC-P2P shall commence or carry on the business of a P2P lending platform without obtaining a Certificate of Registration (COR) from the central bank. Those already in the business can continue with the business but registration has to be obtained. The prudential requirements include a minimum capital of Rs 2 crore.

With a view to ensuring that there is enough skin in the game at a later date, a leverage ratio of P2P lending may be prescribed so that the platforms do not expand with indiscriminate leverage.

Way Forward

In a widening GDP base where the formal economy is rising due to digitisation and introduction of Goods and Services Tax (GST), the financial needs are set to be divergent. In this scenario, P2P lending can become a friendly entity to small and medium industries, which are credit-starved.

When P2P as lending forum picks up pace, productive sectors of the economy and even individuals can source funds. It will be able to step up the economy in a big way. Entrepreneurs and willing lenders will have a win-win situation when P2P becomes a full-blown activity in coming years.

(The author is Director, National Institute of Banking Studies and Corporate Management, Noida)